Charitable income tax deduction one of the few tax shelters remaining

The Obama administration's tax hikes on affluent Americans — along with a strong stock market and fears that the government would push tax rates even higher — led to an increase in giving to donor-advised funds last year.

Major providers of donor-advised funds, which allow investors to make upfront contributions of cash or assets to an investment fund and then gradually dole out the money in the form of grants, enjoyed upticks in fund creation, contributions and grants in 2013 on the heels of higher income and capital gains taxes.

At Schwab Charitable Gift Fund, grants increased by 36% and contributions jumped by 35% last year. The Raymond James Charitable Endowment Fund saw a 24% increase in assets, due equally to market increases and new contributions. At Fidelity Charitable Gift Fund grants jumped 29%, while contributions remained about flat. Meanwhile, Vanguard Charitable Gift Fund saw a 15% increase in the number of grants but a slight decline in contributions.

The broad market index S&P 500 surged about 29.6%. As for as taxes, the American Taxpayer Relief Act of 2012, which took effect Jan. 1, 2013, raised rates on the top income bracket to 39.6% from 35% and on capital gains to 20% from 15%. An additional 3.8% tax on net investment income raised the effective rate on capital gains even further.

Kim Laughton, president of Schwab Charitable, said that, coming on the heels of the creation of a wave of donor-advised funds in 2012, the main drivers of last year's increased contributions were the strong equities market and the higher tax rates on income and capital gains, Ms. Laughton said.

Fears that the debt ceiling negotiations would lead to an elimination of the tax deduction on charitable contributions prompted a wave of fund creations and contributions, she said. Now that many of those funds are issuing grants, charities are reaping the benefits.

“Since people now have a higher effective tax rate than they otherwise thought, they are saying 'how can I shelter my income?'” said Chris Raulston, a wealth strategist at Raymond James. “One of the few remaining tax shelters is the charitable income tax deduction.”

The new taxes, along with a strong equities market, also led to a much larger proportion of donation taking the form of appreciated assets such as stocks and bonds. Fidelity Charitable saw these donations jump to 62% of all contributions, from 54% in 2012. For Schwab Charitable, the assets contributed 65%, a five-year high. At Vanguard Charitable, appreciated assets made up 81% of contributions.

Donating appreciated assets allows investors to avoid paying capital gains tax and deduct the donation from taxable income, said Amy Danforth, senior vice president at Fidelity Charitable. The donor-advised fund can then liquidate the assets at any time so that grant recipients receive cash.

Due to incorrect information provided by Raymond James, a previous version of this story misstated the growth of assets in the Raymond James Charitable Endowment Fund. It grew by 24%, not 35%.